Technical analysis is the method of evaluating traded products by analysing statistics generated by market activity, such as past prices and volumes. Technical analysts believe that the price contains all known information, and therefore technical analysts do not attempt to measure a security's intrinsic value, but instead use charts and other tools to identify patterns that can suggest future activity.
With wonderful-sounding names such as Elliot Wave Theory, Candlestick Charts, Moving Average Convergence Divergence or Bollinger Bands, they all have the common trait of presenting us with a visual approach to market analysis.
In this section, we will introduce to you a handful of popular methods that are currently applied by the market.
Support is the price level at which demand is thought to be strong enough to prevent prices from declining further. Support levels are typically below the current price, though it is not uncommon for prices to briefly dip below support, signalling a false breakout. With a support level broken, the market will move lower, indicating that the sellers have overwhelmed the buyers. Once a support level has been broken, another support level will be established at a lower level, whilst the support level that was breached tends to become a resistance level.
Resistance is the price level at which demand is thought to be strong enough to prevent prices from rising further. Resistance levels are usually above the current price. A clear break above the resistance level signals that the buyers are in control. In this instance, there are fewer sellers and the price tendency is to move further up. Once a resistance level has been broken, another resistance level will be established at a higher level and as with the support level, when the resistance level is breached, this will now become the new support level.
Moving averages are very popular tools used by technical traders to measure momentum. They are usually the first tools that technical analysts are introduced to as they are simple to apply and are building blocks to more complicated moving-average theories. The main purpose of these averages is to smooth price data so traders can be in a better position to gauge the likelihood that a current trend will continue. Moving averages are commonly used to predict areas of support and resistance and are also used in conjunction with other indicators to help give more accurate entry and exit signals. There are different types of averages that vary in popularity, but regardless of how they are calculated, they are all interpreted in the same manner.
We have simple moving averages, weighted moving averages and exponential moving averages. A very simple theory is the moving average crossover. This is where you combine two moving averages with differing timeframes. Where they cross will indicate the entry and exit points to a trader.